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Qui Tam Payment Included in Income

The Eleventh Circuit held that qui tam payments that
a whistleblower received were includible in income. It
further held that the whistleblower, who had included
the payments on his return as other income but had not
included them in the calculation of his tax due, had not
acted in good faith and was liable for a 20%
accuracy-related penalty.

Background

Until 1995, Albert
Campbell was the chief of cost control for a $3.5
billion contract his employer had with the U.S.
government. In 1995, Campbell became a whistleblower
against his former employer (Lockheed). On behalf of the
government, he filed two lawsuits under the Federal
Claims Act, asserting that Lockheed had defrauded the
United States. In 2003, Lockheed settled with the
government for $37.9 million. Campbell received a qui
tam payment of $8.75 million for his role as relator.
The government wired the money to Campbell’s attorneys,
who subtracted their 40% fee of $3.5 million and sent
Campbell a check for the balance of $5.25 million.

The Justice Department issued Campbell a Form
1099-MISC, Miscellaneous Income, for $8.75 million. On
his self-prepared return for 2003, Campbell entered the
$5.25 million net qui tam payment on line 21 as “other
income” but omitted the amount from the calculation of
taxable income on line 40. He also attached Form 8275,
Disclosure Statement, to his 2003 return. Without citing
any authority in support of his assertions, he stated on
the form that the $3.5 million in attorneys’ fees was
not taxable income and that the $5.25 million net qui
tam payment was excludible from his taxable income.

In 2007, the IRS sent Campbell a notice of deficiency
(1) for failing to include the $5.25 million qui tam
payment in his gross income and (2) for an
accuracy-related penalty because his exclusion of the
qui tam payment resulted in a substantial understatement
of income tax. Campbell contested the IRS’s
determination in Tax Court, which held in favor of the
IRS.

Campbell appealed the decision to the Eleventh
Circuit. Campbell argued, relying on Vermont Agency of Natural
Res. v. United States ex rel. Stevens, 529 U.S.
765 (2000), that the qui tam claim was an assignment of
the United States’ reimbursement claim to him and that,
because the payment would not be taxable to the U.S.
government, it should not be taxable to him as an
assignee of the nontaxable claim, since as an assignee
of the claim he stood in the shoes of the U.S.
government in pursuing the claim. Campbell argued that
he was not liable for an accuracy-related penalty
because he had disclosed the payment on the face of his
return and on Form 8275, there was reasonable cause for
omitting the payment from income, and he had acted in
good faith.

Eleventh Circuit’s
Decision

The Eleventh Circuit held that the qui tam payment
was includible in Campbell’s income. The court
rejected Campbell’s assignment argument on the grounds
that in Vermont Agency the Supreme Court, while finding that a relator
in a qui tam claim has standing to assert the
injury-in-fact suffered by the government, did not
rule on whether a qui tam payment was taxable.
Consistent with the decisions of the Tax Court and
other circuit courts that have addressed the issue,
the Eleventh Circuit found that a qui tam payment is
in the nature of a reward and as such is includible in
gross income.

Regarding the
accuracy-related penalty, the court gave Campbell no
credit for disclosing the payment on line 21 of his
return and on Form 8275. It stated that Campbell had not
disclosed the payment in good faith and with reasonable
cause by mentioning it in two places while omitting the
payment from income in the calculation of his tax due,
calling his efforts “an overt and intentional act to
underpay.” The court also found that besides his
inadequate disclosure of the payment, he did not qualify
for either of the exceptions to the imposition of the
accuracy-related penalty because he had not cited any
authorities actually supporting his claim that the qui
tam payment was not includible in income and that he had
not consulted a tax professional when preparing his
return to determine if his treatment of the payment was
correct.

Reflections

Taxpayers cannot use a Form 8275 disclosure as an
all-purpose talisman to ward off the imposition of an
accuracy-related penalty, as this case demonstrates.
Tax practitioners should be aware of the limited
utility of a disclosure and make sure that clients who
are making a disclosure understand the extent of the
protection that it provides.

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